The Brexitconundrum

Author:

Deepak Lal

26.12/2018

Published with the kind permission of the author

Instead of being deterred by a ‘no deal’ scenario, the UK shouldadopt a tit-for-tat strategy with the EU.

Ireturned to London early last week to an extraordinarypolitical landscape. Prime Minister TheresaMay had suffered a tumultuous week in whichshe pulled her European Union (EU) withdrawal Bill,as it became clear, after the attorney general had beenforced to reveal his legal advice to Parliament, that the“backstop” measures to deal with the Irish borderquestion effectively, and indefinitely convertedNorthern Ireland and thereby the United Kingdom(UK) to EU vassals. There is little hope this Bill willpass when reintroduced on January 15.

Meanwhile, Mrs May has become a lame duck,having promised to stand down before the next generalelection, to narrowly win the vote of no confidencebrought by the Tory Brexiteers. Mrs May rightly rejectedthe call for another referendum by the Europhilesas being a betrayal of the democratic decision in the2016 referendum, which was reaffirmed in the manifestosof both major parties in the 2017 election. So lessthan 100 days before the UK is mandated to leave theEU, no one knows what form it will take.

The basic problem with this Brexit conundrum isthat, from the start (in game-theoreticterms), the UK negotiators (mainlyEurophile civil servants) were playingthe wrong game with Michel Barnier— the EU’s chief negotiator. Theythought they were playing a co-operative2-person game in which a mutuallybeneficial solution could be found.In fact, from the statements made bythe European Commission — that itsaim was to have a Brexit deal whichwould inflict substantial damage onthe UK to discourage other potential“exiters” — the EU was playing a 2-person, repeated non-zero sum, non-cooperativegame. The most familiar example of which is thePrisoner’s Dilemma (on which more below).

That the EU was not playing the co-operative gameshould have become clear with the issue of the Irishbackstop to avoid a “hard border” between Irelandand the UK. In an article detailing how this arose, LiamHalligan of Capital Economics argues (in “The ‘vexedquestion’ of the Irish Backstop”, Sunday Telegraph,December 18) that the responsibility lies with theyoung, gay, Parsi, Leo Vardakar, the Irish Taoiseachsince June 2017. After the Brexit referendum, his predecessorEdward Kenny had sought a negotiated solution.The UK and Irish civil servants set to work, onschemes “to cope with cross-border trade flows which,while important to local communities, are really rathersmall”. Mr Vardakar disbanded them and ended directUK-Irish collaboration. In November 2017, Mr Vardakarupped the stakes “demanding Britain sign a ‘backstop’— making it impossible to leave the EU’s customsunion unilaterally, while drawing a border down theIrish Sea.” But as Mr Halligan argues, citing various cuscustomsand tax specialists, this ‘hard’ Irish border is fictitious.“The WTO visiting Ireland last month confirmedno new border infrastructure is needed.” Theexisting largely virtual border “already copes with differentcurrencies, excise duties, VAT rates, income andcorporation tax. There is no reason minor trading rulevariations can’t also be managed”.

It is time, therefore, for Mrs May to withdraw herWithdrawal Bill, and instead present an exit Bill basedon the repeated Prisoner’s Dilemma game, the objectiveof which is to negotiate a free-trade agreement(FTA) with the EU. As Robert Axelrod showed in his TheEvolution of Cooperation, from a tournament of gametheorists presenting their strategies for the repeatedPrisoner’s Dilemma non-cooperative game, that thewinning strategy was “Tit for Tat”.

So, Mrs May should announce in January that theUK will leave the EU customs union and single marketas well as the jurisdiction of the European Court ofJustice on March 29. But, to facilitate the negotiationof a free-trade arrangement with the EU, the UK willprovide duty-free access to imports from the EU for alimited period. If the EU reciprocateswith similar duty-free access forBritish exports for the period it takes tocomplete a legal FTA, there would beno change in the import/export tradingstatus quo after March 29. Therewould be no need for lorry parks,stocking of food and medicines, ordisturbance of supply chains.

If instead, the EU puts on its externaltrade tariff for non-members, theUK will also levy its WTO tariffs onEU imports and initiate immediatetalks with the US, Australia and NewZealand for FTAs. Given that the bound EU agriculturaltariffs are the highest on competitive imports fromnon-EU agricultural exporters, concluding such FTAsshould mitigate some of the damage to the UK’s agriculturalexporters, whilst, by allowing imports fromnon-EU sources, food prices in the UK should fall. TheUK’s levying of the bound WTO tariff on agriculturalimports from the EU should hurt their agriculturalproducers, particularly the French who have been themost reluctant to offer the UK a mutually beneficialtrade deal. For non-agricultural EU imports into theUK, applying WTO tariffs should hurt Germany --another recalcitrant on an FTA with the UK. Its industrialexports, particularly of cars, would be hit, with itbeing estimated that this “could slash German exportsto the UK by 57 per cent”, threatening “more than750,000 jobs in Germany which depend on exports toBritain” (Ambrose Evans-Pritchard, “It is time to breakfree as Germany fears no-deal cost”, Daily Telegraph,December 20).

For non-agricultural UK exports, EU barriers totrade consist of tariffs and non-tariff barriers (like standards).The latter have already been incorporated intoUK domestic law through the Great Repeal Bill. Thismeans there would be no change in the administrativeprocesses for meeting these standards for UK exportsto the EU (including Ireland), and no need for any newsurveillance and administrative machinery after Brexit.

Tariffs would be the only new trade barrier on UKexports. These can be collected and monitored as partof the existing Irish and EU administrative machinerythat monitors standards. There is no need for any newphysical or other infrastructure, and hence no need forany Irish “backstop”.

Would the replacement of the UK’s current tarifffreeaccess to the EU by the common external tariffcharged to non-members greatly damage the UK economy?Under WTO rules, the EU would not be able toraise its tariffs on UK exports above the WTO bound tariff.The table (European Union common external tariffs)shows that the EU’s simple average final bound tarifffor all goods is 5.5 per cent, with that for agriculturalgoods being substantially higher at 13.5 per cent thanfor non-agricultural goods of 3.9 per cent.

To judge how little this would affect UK exportersto the EU, the graph (British Pound vs Euro) shows thefluctuations in the euro/pound exchange rate over thelast year. The rate falls by 5.2 per cent between April andAugust and rises by 5.5 per cent between August andOctober. The average EU bound WTO tariff falls withinthis range. It is difficult to believe that exporterswould not be able to easily absorb the tariffs.

That playing tit for tat would work is borne out by theresponse in the EU and Ireland to the failure of MrsMay’s Withdrawal Bill to pass and the growing likelihoodof a “No Deal”. The EU in its “no deal” preparationshas already granted a year’s legal reprieve to the derivativesmarket based in London and a temporary “basicconnectivity” plan keeping British planes flying and lorriestravelling to the EU. Whilst Leo Vardakar has suggestedIreland would seek to maintain an open borderwith the UK even with a “no deal” Brexit, (FinancialTimes, December 21). This gives the lie to the need foran Irish backstop in a withdrawal Bill. Hence, if Mrs Mayfollows the simple tit-for-tat strategy outlined above,Britain may hope to have a Happy New Year.